What Is Evidential Matter?
Evidential matter, also known as audit evidence, refers to all the information an auditor uses to draw conclusions on which the audit opinion is based. This comprehensive body of information includes both data that supports and corroborates management's assertions regarding the financial statements and information that contradicts them. Within the broader field of auditing, evidential matter is the foundation of the audit process, enabling an auditor to assess whether financial statements are presented fairly in all material respects, in accordance with applicable accounting frameworks such as Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS).
History and Origin
The concept of audit evidence has evolved significantly with the formalization of the auditing profession. Early auditing practices, particularly in the 19th century, focused primarily on verifying financial transactions to ensure accuracy and detect fraud. As businesses grew in complexity and public investment became more widespread, the need for standardized procedures and reliable evidence became paramount. Professional accounting bodies, such as the American Institute of Certified Public Accountants (AICPA), began to establish guidelines emphasizing objectivity and ethical conduct in audits. [The CPA Journal] notes that by 1926, over 90% of companies on the New York Stock Exchange were audited by Certified Public Accountants, even before it was a listing requirement.1
A pivotal moment arrived with the establishment of the U.S. Securities and Exchange Commission (SEC) in 1934, which mandated audited financial statements for publicly traded companies. This regulatory shift underscored the importance of robust evidential matter. Later, landmark legislation such as the Sarbanes-Oxley Act of 2002 led to the creation of the Public Company Accounting Oversight Board (PCAOB), further solidifying the requirements for auditors to obtain sufficient, appropriate audit evidence to support their conclusions.
Key Takeaways
- Evidential matter is all the information auditors use to form their opinion on financial statements.
- It must be both sufficient (quantity) and appropriate (quality, relevance, and reliability).
- Sources of evidential matter include internal records, external confirmations, and direct observation.
- Auditors use various procedures, such as sampling, inquiry, and inspection, to gather evidential matter.
- The nature and extent of evidential matter required depend on the assessed audit risk and the materiality of the financial statement accounts.
Interpreting the Evidential Matter
The interpretation of evidential matter is a critical aspect of the auditing process, requiring the auditor to exercise professional judgment and skepticism. Auditors assess the information gathered based on its sufficiency and appropriateness. Sufficiency relates to the quantity of audit evidence, which is influenced by the risk of material misstatement—the higher the risk, the more evidence is generally required. Appropriateness, conversely, is the measure of the quality of the audit evidence, encompassing its relevance and reliability. Evidence obtained from independent external sources or directly by the auditor is generally considered more reliable than internally generated or indirect evidence. For instance, confirmation of a bank balance directly from the bank provides more reliable evidential matter than a bank statement provided by the client. The auditor must weigh the persuasiveness of the evidence, considering potential biases or inconsistencies, to conclude whether it adequately supports or contradicts management's assertions.
Hypothetical Example
Consider an external audit of a manufacturing company. The auditor needs to verify the existence and valuation of the company's inventory balance, a significant figure on the financial statements.
- Observation: The auditor attends the company's year-end physical inventory count, observing the procedures followed by company personnel and performing test counts of selected inventory items. This provides direct evidential matter regarding the physical existence of the inventory.
- Inspection: The auditor then inspects inventory records, such as receiving reports, perpetual inventory records, and production logs, to trace the flow of inventory items and reconcile them with the physical count. This provides evidential matter about the completeness and accuracy of recorded inventory.
- Inquiry and Recalculation: The auditor inquires about obsolete or slow-moving inventory and recalculates the valuation of inventory based on costing methods (e.g., FIFO or weighted-average) to ensure compliance with Generally Accepted Accounting Principles and proper valuation.
- External Confirmation: For inventory held at a third-party warehouse, the auditor sends confirmation requests directly to the warehouse to verify the quantities held.
By combining these procedures, the auditor gathers diverse evidential matter to form a comprehensive understanding of the inventory balance and assess its fair presentation.
Practical Applications
Evidential matter is central to every aspect of an auditing engagement and assurance services. Beyond forming an audit opinion on financial statements, it is crucial in evaluating the effectiveness of a company's internal controls. Auditors perform tests of controls, gathering evidential matter to determine if controls are operating effectively, which in turn influences the nature, timing, and extent of substantive procedures.
Regulatory bodies heavily rely on the concept of evidential matter. For instance, the Public Company Accounting Oversight Board's Auditing Standard 1105 explicitly outlines what constitutes audit evidence and establishes requirements for obtaining sufficient appropriate evidence in audits of public companies. Similarly, the International Auditing and Assurance Standards Board's ISA 500 provides global guidance on the same. The failure to obtain sufficient appropriate evidential matter can lead to severe consequences, including restatements of financial results, penalties, and even enforcement actions by regulators such as the U.S. Securities and Exchange Commission, as seen in cases involving audit deficiencies.
Limitations and Criticisms
Despite its critical role, obtaining and evaluating evidential matter comes with inherent limitations. The cost-benefit principle in auditing dictates that the cost of obtaining evidence should not exceed the benefits derived from it, which can sometimes limit the extent of procedures. Auditors typically do not examine every transaction, relying instead on sampling and professional judgment, which introduces a degree of inherent audit risk.
Furthermore, the reliability of evidential matter can be compromised. For example, evidence generated internally by a client may be subject to manipulation, especially if internal controls are weak. The reliability of evidence obtained from external sources can also be affected by the integrity of the source. Auditors must maintain professional skepticism, a questioning mindset and critical assessment of audit evidence, throughout the audit process to mitigate these risks. Challenges also arise with the increasing complexity of financial instruments and the pervasive use of technology, requiring auditors to adapt their techniques for gathering and evaluating digital evidential matter.
Evidential Matter vs. Audit Documentation
While closely related and often used interchangeably in casual conversation, "evidential matter" and "Audit Documentation" refer to distinct concepts in auditing.
- Evidential Matter: This is the information itself that the auditor gathers. It includes everything from financial records and invoices to confirmations, observations, and oral representations. It is the raw data and knowledge an auditor accumulates to support their conclusions.
- Audit Documentation: This refers to the record of the audit procedures performed, the evidential matter obtained, and the conclusions reached by the auditor. It is the physical or electronic working papers that support the audit report. Audit documentation serves to provide evidence that the audit was planned and performed in accordance with auditing standards, facilitate the supervision and review of the audit work, and provide a record of matters of continuing significance to future audits.
In essence, evidential matter is what the auditor collects, while audit documentation is how that collection, evaluation, and conclusion process is formally recorded and organized.
FAQs
What are the characteristics of good evidential matter?
Good evidential matter is both sufficient and appropriate. Sufficiency refers to the quantity of the evidence, meaning enough evidence has been gathered. Appropriateness refers to the quality of the evidence, which includes its relevance to the audit objective and its reliability. Reliability is generally higher for evidence obtained from independent external sources or directly by the auditor, and when internal internal controls are strong.
How do auditors gather evidential matter?
Auditors use various audit procedures to gather evidential matter. These include inspection (examining records or assets), observation (watching a process being performed), inquiry (seeking information from knowledgeable persons), confirmation (obtaining direct responses from third parties), recalculation (checking mathematical accuracy), reperformance (independently executing procedures or controls), and analytical procedures (evaluating financial information through plausible relationships). The specific combination of procedures depends on the nature of the account and the assessed risks.
Why is evidential matter important in an audit?
Evidential matter is crucial because it forms the basis for the auditor's professional judgment and conclusions regarding the fairness of the financial statements. Without sufficient appropriate evidential matter, an auditor cannot provide a reasonable basis for an audit opinion, which could lead to an unqualified opinion being issued incorrectly or a qualified/adverse opinion being necessary. It also demonstrates that the auditing engagement was conducted in accordance with established professional standards.